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Munn & Morris Financial Advisors, Inc.

Phil Orwig, CFP


Financial Planner
14180 Dallas Parkway
Suite 530
Dallas, TX 75254
972-692-0909
porwig@munnmorris.com
www.munnmorris.com

Net Unrealized Appreciation:


The Untold Story
If you participate in a 401(k), ESOP, or other qualified
retirement plan that lets you invest in your employer's
stock, you need to know about net unrealized
appreciation--a simple tax deferral opportunity with an
unfortunately complicated name.
When you receive a distribution from your employer's
retirement plan, the distribution is generally taxable to
you at ordinary income tax rates. A common way of
avoiding immediate taxation is to make a tax-free
rollover to a traditional IRA. However, when you
ultimately receive distributions from the IRA, they'll
also be taxed at ordinary income tax rates. (Special
rules apply to Roth and other after-tax contributions
that are generally tax free when distributed.)

All investing involves


risk, including the loss of
principal. This discussion
explains the tax
treatment that may be
available when employer
stock is held in a
qualified retirement plan.
While the examples used
in the discussion show
such stock increasing in
value over time, it is
important to understand
that any shares of stock
held in a retirement plan,
including shares of
employer stock, can lose
some or all of their value
over time.

But if your distribution includes employer stock (or


other employer securities), you may have another
option--you may be able to defer paying tax on the
portion of your distribution that represents net
unrealized appreciation (NUA). You won't be taxed on
the NUA until you sell the stock. What's more, the
NUA will be taxed at long-term capital gains
rates--typically much lower than ordinary income tax
rates. This strategy can often result in significant tax
savings.

What is net unrealized appreciation?


A distribution of employer stock consists of two parts:
(1) the cost basis (that is, the value of the stock when
it was contributed to, or purchased by, your plan), and
(2) any increase in value over the cost basis until the
date the stock is distributed to you. This increase in
value over basis, fixed at the time the stock is
distributed in-kind to you, is the NUA.
For example, assume you retire and receive a
distribution of employer stock worth $500,000 from
your 401(k) plan, and that the cost basis in the stock
is $50,000. The $450,000 gain is NUA.

How does it work?


At the time you receive a lump-sum distribution that
includes employer stock, you'll pay ordinary income
tax only on the cost basis in the employer securities.

You won't pay any tax on the NUA until you sell the
securities. At that time the NUA is taxed at long-term
capital gain rates, no matter how long you've held the
securities outside of the plan (even if only for a single
day). Any appreciation at the time of sale in excess of
your NUA is taxed as either short-term or long-term
capital gain, depending on how long you've held the
stock outside the plan.
Using the example above, you would pay ordinary
income tax on $50,000, the cost basis, when you
receive your distribution. (You may also be subject to
a 10% early distribution penalty if you're not age 55 or
totally disabled.) Let's say you sell the stock after ten
years, when it's worth $750,000. At that time, you'll
pay long-term capital gains tax on your NUA
($450,000). You'll also pay long-term capital gains tax
on the additional appreciation ($250,000), since you
held the stock for more than one year. Note that since
you've already paid tax on the $50,000 cost basis,
you won't pay tax on that amount again when you sell
the stock.
If your distribution includes cash in addition to the
stock, you can either roll the cash over to an IRA or
take it as a taxable distribution. And you don't have to
use the NUA strategy for all of your employer
stock--you can roll a portion over to an IRA and apply
NUA tax treatment to the rest.

What is a lump-sum distribution?


In general, you're allowed to use these favorable NUA
tax rules only if you receive the employer securities
as part of a lump-sum distribution. To qualify as a
lump-sum distribution, both of the following conditions
must be satisfied:
It must be a distribution of your entire balance,
within a single tax year, from all of your employer's
qualified plans of the same type (that is, all
pension plans, all profit-sharing plans, or all stock
bonus plans)
The distribution must be paid after you reach age
59, or as a result of your separation from service,
August 11, 2015
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or after your death


There is one exception: even if your distribution
doesn't qualify as a lump-sum distribution, any
securities distributed from the plan that were
purchased with your after-tax (non-Roth)
contributions will be eligible for NUA tax treatment.
NUA at a glance

If you're expecting a
distribution of employer
securities from a
qualified retirement plan,
make sure you speak
with your financial or tax
professional before you
take any action so that
you can fully explore and
understand all the
options available to you.
Only then can you be
assured of making the
decision that best meets
your individual tax and
nontax goals.
*Diversification is a
method used to help
manage investment risk;
it does not guarantee a
profit or protect against
investment loss.

You receive a lump-sum distribution from your


401(k) plan consisting of $500,000 of employer
stock. The cost basis is $50,000. You sell the
stock 10 years later for $750,000.*
Tax payable at distribution--stock valued at
$500,000
Cost basis--$50,000

NUA--$450,000

Taxed at ordinary income


rates; 10% early payment
penalty tax if you're not 55
or disabled
Tax deferred until sale of
stock

Tax payable at sale--stock valued at $750,000


Cost basis-- $50,000 Already taxed at
distribution; not taxed
again at sale
NUA-- $450,000

Taxed at long-term capital


gains rates regardless of
holding period

Additional
appreciation-$250,000

Taxed as long- or
short-term capital gain,
depending on holding
period outside plan
(long-term in this example)

*Assumes stock is attributable to your pretax


and employer contributions and not after-tax
contributions

NUA is for beneficiaries, too


If you die while you still hold employer securities in
your retirement plan, your plan beneficiary can
also use the NUA tax strategy if he or she receives
a lump-sum distribution from the plan. The taxation
is generally the same as if you had received the
distribution. (The stock doesn't receive a step-up in
basis, even though your beneficiary receives it as
a result of your death.)

If you've already received a distribution of employer


stock, elected NUA tax treatment, and die before you
sell the stock, your heir will have to pay long-term
capital gains tax on the NUA when he or she sells the
stock. However, any appreciation as of the date of
your death in excess of NUA will forever escape
taxation because, in this case, the stock will receive a
step-up in basis. Using our example, if you die when
your employer stock is worth $750,000, your heir will
receive a step-up in basis for the $250,000
appreciation in excess of NUA at the time of your
death. If your heir later sells the stock for $900,000,
he or she will pay long-term capital gains tax on the
$450,000 of NUA, as well as capital gains tax on any
appreciation since your death ($150,000). The
$250,000 of appreciation in excess of NUA as of your
date of death will be tax free.

Some additional considerations


If you want to take advantage of NUA treatment,
make sure you don't roll the stock over to an IRA.
That will be irrevocable, and you'll forever lose the
NUA tax opportunity.
You can elect not to use the NUA option. In this
case, the NUA will be subject to ordinary income
tax (and a potential 10% early distribution penalty)
at the time you receive the distribution.
Stock held in an IRA or employer plan is entitled to
significant protection from your creditors. You'll
lose that protection if you hold the stock in a
taxable brokerage account.
Holding a significant amount of employer stock
may not be appropriate for everyone. In some
cases, it may make sense to diversify your
investments.*
Be sure to consider the impact of any applicable
state tax laws.

When is it the best choice?


In general, the NUA strategy makes the most sense
for individuals who have a large amount of NUA and a
relatively small cost basis. However, whether it's right
for you depends on many variables, including your
age, your estate planning goals, and anticipated tax
rates. In some cases, rolling your distribution over to
an IRA may be the better choice. And if you were
born before 1936, other special tax rules might apply,
making a taxable distribution your best option.

This information, developed by an independent third party, has been obtained from sources considered to be reliable, but Raymond James
Financial Services, Inc. does not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or
statement of all available data necessary for making an investment decision and does not constitute a recommendation. The information
contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. This
information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable
for all investors. The material is general in nature. Past performance may not be indicative of future results. Raymond James Financial Services,
Inc. does not provide advice on tax, legal or mortgage issues. These matters should be discussed with the appropriate professional.
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC, an independent broker/dealer, and are not insured
by FDIC, NCUA or any other government agency, are not deposits or obligations of the financial institution, are not guaranteed by the financial
institution, and are subject to risks, including the possible loss of principal.

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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2015

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